Charitable Trusts: Income Tax Perspective

ARE INCOME TAX AUTHORITIES REALLY CHARITABLE WHEN IT COMES TO CHARITABLE TRUSTS?

CHARITABLE TRUSTS: INCOME TAX PERSPECTIVE

‘Charity begins at home but should not end there.’ –Francis Bacon

 The essence of the above quote has been fully captured in the definition of the expression “charitable purpose” as envisaged in the Income Tax Act, 1961.

Under the Indian Income Taxation Laws, a trust is considered as charitable, if its objects are directed to the benefit of the society at large and not for an individual or group of individuals.

More specifically section 2(15) of the Income Tax Act, 1961, defines the expression “charitable purpose” as under:

Section 2(15) : “charitable purpose” includes relief of the poor, education, yoga, medical relief, preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places or objects of artistic or historic interest, and the advancement of any other object of general public utility:

Provided that the advancement of any other object of general public utility shall not be a charitable purpose, if it involves the carrying on of any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to any trade, commerce or business, for a cess or fee or any other consideration, irrespective of the nature of use or application, or retention, of the income from such activity, unless—  

(i)  such activity is undertaken in the course of actual carrying out of such advancement of any other object of general public utility; and

(ii)  the aggregate receipts from such activity or activities during the previous year, do not exceed twenty per cent of the total receipts, of the trust or institution undertaking such activity or activities, of that previous year;

Owing to its aim of social development of the country, charitable trusts have received favoured and preferential treatment in the Indian Taxation Laws, since 1886.

The taxation of charitable trusts is governed by Chapter III of the Income Tax Act which contains sections 11, 12, 12A, 12AA and 13.

Section 12A/12AA contains the provisions concerning the Registration and the Registration Procedure under the Income Tax Act. Section 11 and 12 contains the provisions concerning the conditions to be fulfilled by the charitable trusts in order to claim exemption from income tax. Section 13 stipulates the provisions concerning the trusts which are not eligible for exemption u/s 11 & 12.

1. Conditions for applicability of sec 11 and 12

In order to secure exemption u/s 11, the property must be held under trust, besides section 12A lays down that the exemption under section 11 and 12, shall not be available unless the following conditions are fulfilled:

(a) Registration: The trust is required to obtain registration u/s 12AA with the Commissioner of Income-tax..

(b) Compulsory Audit: Where the total income of the trust or institution, exceeds the basic exemption limit, that is, Rs.2, 50,000/- in any previous year, the accounts of the trust or institution is required to be audited by a qualified Chartered Accountant, and the audit report in Form No. 10B is required to be furnished electronically before filing the e-return of income.

2. Filing of Return [ Sec 139(4A) ]

Where the total income of the trust (before allowing exemption under sections 11 and 12) exceeds the maximum amounts which is not chargeable to tax (i.e. Rs.2,50,000 for A.Y.2015-16 and onwards), it is required to file its return in Form ITR-7, before the date specified in section 139. The due date specified under section 139 is 30^th September every year where the trust is required to get its accounts audited under any provision of the Act and 31^st July every year in other case.

In case return is not filed by prescribed date then benefit of accumulation u/s 11(2) will not be available. [sec 13(9)inserted w.e.f. 1.4.2016]

3. Income Applied to Charitable or Religious Purposes [Sec 11(1)]

Section 11(1) of the Income Tax lays down that any income, profits and gains derived from property held under trust wholly for religious and charitable purposes, (or held in part only for such purposes-in case of trust created before 1/4/1962) shall not be included in the total income of the trust or institution (including a society or any other legal obligation) to the extent such income is applied or accumulated for application to such purposes. The exemption is, allowable under specified circumstances, on fulfillment of certain conditions.

In order to be eligible for claiming exemption, it is essential that the income of the trust is applied to such objects. A charitable trust or institution will have to apply at least 85 % of the income to charitable purposes. If the income spent on charitable or religious purposes, during the previous year, falls short of 85 % of the income derived during the year, such shortfall will be liable to tax. Voluntary contribution or donations (not being contributions made with a specific direction that they will form part of the the corpus) will be deemed to be a part of income derived from property held under trust.

4. Exemption for Accumulation of Income in Excess of Specified Limit [Sec 11(2)]

Where 85% of income derived from trust property is not applied or is not deemed to have been applied for charitable purposes, but is accumulated or set apart for application for such purposes in India, exemption can be claimed for the income so accumulated or set apart in excess of 15% limit, provided the following conditions are complied with:

(a) a statement in form 10B to be uploaded electronically within the time allowed for furnishing the return u/s 139(1), notifying the amount being accumulated and the period of accumulation. In case form no. 10B is not uploaded before this date then the benefit of accumulation will not be available and such income will be taxable at appropriate rate.

(b) the period of accumulation does not exceed 5 years and

(c) the money so accumulated is invested or deposited in modes or forms specified u/s 11(5).

(d) From A.Y.2016-17 benefit of accumulation is not available if return of income is not furnished before due date of filing return as per Sec 139(1).

5. Are Charitable Trusts allowed to carry forward their losses/deficits of the earlier years for set-off against their incomes of subsequent years?

Till very recently, the Revenue Authorities were very consistently disallowing the charitable trusts’ claim of carry forward of their losses/deficits of the earlier years for setoff against their incomes of subsequent years, and thus such deficits were considered as dead losses.

However, the issue of allowability of the claim of loss u/s 11 and carry forward of the same to subsequent year to be set off against incomes of subsequent years by the charitable trusts is no longer “Res Intigra” as the Hon’ble Supreme Court in the case of “CIT(Exemptions) vs. Subros Educational Society” (2018) 303 CTR 1 / 166 DTR 257 (SC), have upheld the judgement of the jurisdictional Hon’ble Delhi High Court, in the same case reported in IT No. 382 of 2015 dated 23.9.2015, and have categorically dismissed the SLP being filed by the Revenue Authorities against the said judgement.

In the said judgement the Hon’ble Supreme Court have categorically answered the following question of law in AFFIRMATIVE, viz.

“Whether any excess expenditure incurred by the trust/charitable institution in earlier assessment year could be allowed to be set off against income of subsequent years by invoking Section 11 of the Income Tax Act, 1961?”

Therefore, in view of the binding judgement of the Hon’ble Supreme Court in the case of “CIT(Exemptions) vs. Subros Educational Society” (2018) 303 CTR 1 / 166 DTR 257 (SC), as above, the issue of allowability of the claim of loss u/s 11 and carry forward of the same to subsequent year to be set off against incomes of subsequent years by the charitable trusts, has attained finality in favour of charitable trusts assessees and as such from now onwards, there should not be any question of any disallowance in this regards, by the ld. Assessing Authority.

6. Corpus Donations towards Corpus Funds are fully exempt and there is no requirement of fulfilment of the stipulated criteria of application of atleast 85% for such Corpus Donations [Sec 11(1)(d)]

Corpus donations refer to the donations made by a donor to a trust with a specific direction that they shall form part of the corpus of the recipient trust. The donor alone can give a specific direction that the donation made by him shall form part of the corpus of the trust. Trustees have no power to treat in their discretion any donation as corpus donation. Such direction may preferably be given by the donor in writing by a letter addressed to the trust. If he has not done so, trustees may request him to give such directions in writing. If any contribution is made with a specific direction, that it shall be treated as the capital of the trust for carrying out a particular charitable activity, it satisfies the definition part of the corpus.

Corpus donations being capital receipt in the hands of the recipient trust are not income of the trust. Section 11(1)(d) expressly grants exemption to corpus donations Contributions to corpus fund kept in fixed deposit cannot be taxed as income even if corpus fund is misused -CIT v Sri Durga Nimishambha Trust [2012] 205 Taxman 59 (Mag) (Kar).

The corpus would include funds of a capital nature, by whatever name called, such as Building Fund, as well as funds for capital expenditure of the trust. Any donation made for a capital purpose or with a direction that donation be kept intact and only the interest received on the investment of such donation be utilized for the objects of the trust, would be a donation towards the corpus of the trust.

Corpus donations may not be applied to charitable purposes and these may be retained as forming part of the corpus of the trust without attracting any tax liability in the matter. The trustees must however utilize the income accruing from the corpus for charitable purposes of the trust.

7. Withdrawal of Exemption granted to Income accumulated u/s 11(2)

The income which is accumulated or set apart in accordance with the provision of Section 11(2), shall become taxable if-

(a) It is applied to purpose other than charitable or religious purposes;

(b) It ceases to remain invested in the specified form or modes of deposit; or

(c) It is not utilized for charitable or religious purposes within the specified accumulation period (which shall not exceed 10 years/5 years in respect of income accumulated on or after 1.4.2001); or

(d) It is paid or credited to any trust/institution registered u/s12AA or to any fund/institution/trust/university/other educational institution/hospital/any other medical institution referred to in clauses (iv), (v), (vi), and (via) of Section 10(23C)^.

Under any of the aforesaid circumstances, the amount involved shall be deemed to be income of the previous year in which it is so misapplied or ceases to be so accumulated or ceases to remain invested or is credited or paid or the previous year immediately following the expiry of the specified accumulation period, as the case may be. [Sec 11(3)].

8. Charitable Trust Carrying on a Business [ Sec 11(4) & 11(4A)]

“Benevolence today has become altogether too huge an undertaking to be conducted otherwise than on business lines.” –Julius Rosenwald

There is no prohibition on a charitable trust carrying on a business. A charitable trust can be settled in relation to any property including a business undertaking. The income from such business shall also qualify for exemption provided the other conditions of sections11 and 12 are fulfilled.

The income of such business shall be determined in accordance with the provisions of the Act. i.e Section 28 to 44 DB. Where the income from such business as determined by the Assessing Officer is found to be in excess of the income shown in the accounts, then such excess shall be deemed to have been applied to non-charitable or non-religious purposes and such excess income shall not qualify for exemption . As per sec 11(4) income of any business held in trust for charitable purpose shall be eligible for exemption . 4

Further, any income of a trust being profits and gains of business, shall not qualify for exemption unless the business is incidental to the attainment of the objects of the trust and separate books of account are maintained in respect of such business as per Sec 11(4A).

The Supreme Court in the case of Asst. CIT vs. Thanthi Trust (2001) 247 ITR 785 (SC) has held that all that is required for the business income of a trust or institution to be exempt from tax is that the business should be incidental to the attainment of objective of the trust or institution. A business whose income is utilised by the trust or the institution for the purposes of achieving the objectives of the trust or the institution is a business which is incidental to the attainment of the objectives of the trust or institution.

Thus, in determining whether the trust is entitled to exemption u/s 11, the nature or type of the sources of income of the trust is not relevant. What is necessary to be considered is whether having regard to all the facts and circumstances of the case, the dominant object of the activity is profit-making or carrying out a charitable purpose. This involves, in each case an examination of not only the objects of the trust but also the manner in which the activities for advancing the charitable purpose are being carried on and the surrounding circumstances. Hon’ble Supreme Court in the case of DIT vs. Bharat Diamond Bourse (2003) 126 Taxman 365 (SC) has held that if the primary or dominant purpose of the institution is charitable and another which by itself, may not be charitable, but is merely ancillary or incidental to the primary or dominant object, it would not prevent the institution from validly being recognized as a charity. The test to be applied is, whether the object which is said to be non- charitable is the main or primary object of the trust or institution or it is ancillary or incidental to the dominant object which is charitable.

9. Exemption in relation to capital gains [Sec 11(1A)].

The amount of exemption in relation to capital gains arising on transfer of a capital asset of charitable trusts shall be as under:

i. Where the capital asset is held under trust wholly for charitable or religious purposes:

a. If the whole of the net consideration is utilised for acquisition of a new capital asset, the entire capital gain shall be exempt; and

b. if only a part of the net consideration is so utilized , the amount of capital gain exempt shall be equal to – Cost of Acquisition of the New Capital Asset Minus Cost of Capital Asset Transferred

ii. Where the capital asset is held under trust in part only for charitable or religious purposes:

a. if the whole of the net consideration is utilized for acquisition of new capital asset, the amount of capital gain exempt shall be equal to,

(A/B * Total Capital Gain)

b. if only a part of the net consideration is so utilized, the amount of capital gain exempt, shall be equal to,

c. [A/B * ( Cost of Acquisition – A/B * ( Cost of Capital Of New Capital Asset) Asset Transferred ) ]

Where

A= Income derived from the capital asset transferred and applied to charitable or religious purpose, before its transfer,

B= Total income derived from the capital asset before its transfer.

Explanatory Notes: –

(i) Cost of Capital Asset Transferred means the aggregate of cost of acquisition of the asset and cost of any improvement thereto. In case of long-term capital assets, the indexed cost of acquisition and indexed cost improvement shall be considered.

(ii) Net consideration means= full value of consideration less expenses in connection with transfer.

(iii) Capital Gains to be calculated as per applicable provisions of the Act.

10. New Capital Asset – Whether includes Fixed Deposit?

While examining this question, the Board had clarified that investment of the net consideration in fixed deposit with a Bank for a period of 6 months or above would be regarded as utilization of the net consideration for acquisition of another capital asset within the meaning of section 11(1A) [Vide CBDT’s Instruction No:883 dated 24.9.1975,  Taxman’s Direct Taxes Circular 1994 Ed. Vol. I, page 1.326].

In CIT vs. East India Charitable Trust (1994) 2016 ITR 152, the Calcutta High Court has held that in view of section 11(5)(vii), deposits with public sector companies, shall qualify as ‘new capital asset’ within the meaning of section 11(1A).

It is pertinent to mention here that the charitable trusts have an option to either claim specific exemption u/s 11(1A) in relation to the capital gains or to claim general exemption u/s 11(1)(a) by applying atleast 85% of the total income including the sale proceeds of sold capital assets towards their charitable objectives.

11. Trusts Not Eligible for Exemption [Sec 13]

Following trusts are not eligible for exemption under Section 11 and 12:

(a) A trust for private religious purposes, which enures no public benefit: [Sec 13(1)(a)]

(b) A charitable trust created or established on or after 1.4.1962 for the benefit of any particular religious community or caste [Sec 13(1)(b)] (other than scheduled castes/tribes, back-ward classes or women and children). (Explanation 2)

(c) A trust or institution for charitable or religious purposes, if any part of its income or property is used or applied, or enure, directly or indirectly for the benefit of a person specified u/s 13(3) viz.(i) the author or founder of the trust ; (ii) a substantial contributor whose total contributions to the trust upto the end of the relevant previous year exceed Rs.50,000; (iii) where the author or contributor is an HUF, a member of the family; (iv) the trustee or manger of the trust; (v) any relative of such author, founder, contributor, member, trustee or manager; and (vi) any concern in which any of the persons aforesaid has a substantial interest. [Sec 13(1)(c)]

12. When Application of Funds deemed to have been made for the benefit of specified Persons- [Sec 13(2)]

Applications of the trust-income or the trust-property for the following purposes is deemed to have been made for the benefit of specified persons.

(a) If a loan is given to a specified person for any period during the previous year without either adequate security or adequate interest or both;

(b) If any land, building or other property of the trust, is allowed to be utilized by a specified person, without charging adequate rent or other compensation:

(c) If payment is made by way of salary, allowance, etc. to a specified person for services rendered by him to the trust or institution, in excess of what may be reasonably paid for such services;

(d) If the trust renders its services to a specified person without adequate remuneration or other compensation; (Exception Medical/Educational Institution)

(e) If any share, security or other property is transferred to the trust from a specified person, for a consideration which is more than adequate;

(f) If any share, security or other property is transferred by the trust to a specified person, for inadequate consideration;

(g) If any income or property of the trust, exceeding Rs. 1000 in value, is diverted to a specified person; and

(h) If the trust-funds are invested, or remain invested, for any period in any concern wherein any of the specified persons has a substantial interest.[Sec 13(2)]

13. Recent Amendments incorporated by Legislature:

“My business is the enforcement of the tax laws and the integrity of the tax code and making sure that trustees of charitable giving are true trustees.”-Chuck Grassley

With instances of misuse of funds by trusts owned by corporate entities, the Government is continuously tightening the law to bring more transparency in the working of charitable trusts. Some of the prominent amendments being incorporated by the Legislature in this regards are listed as under:

1) Levy of tax at the maximum marginal rate where a charitable trust ceases to exist or converts into a non-charitable entity (Secs.115 TD to 115TF) inserted wef-1.6.2016

Section 11 and 12 provide for exemption to trusts or institution in respect of income derived from property held under trust and voluntary contributions, subject to various conditions contained in the said sections. A charitable trust may voluntarily wind up its activities and dissolve or may also merge with any other non–charitable institution, or to may convert into a non – charitable organisation. Moreover, it is always possible for charitable institutions to transfer assets to a non-charitable institution. In such cases, the existing law does not provide for an clarity as to how the assets of such a charitable institution shall be charged to tax.

In order to ensure that the benefit conferred over the years to charitable trust is not misused, section 115 TD is inserted with effect from June 1, 2016. This section provides for levy of additional income –tax in case of conversion into, or merger with, any non- charitable form or on transfer of assets of a charitable organisation on its dissolution to a non-charitable institution. The elements of the regime are-

Time of accreted income – The accretion in income (accreted income) of the trust or institution shall be taxable on-

Conversion of trust or institution into a from not eligible for registration under section 12 AA ; or

Merger into an entity not having similar objects and which is not registered under section 12 AA; or

Non –distribution of assets on dissolution to any charitable institution registered under section 12AA or approved under section 10(23C) within a period of 12 months for dissolution.

• Deemed conversion – For the above purpose, a trust or institution shall be deemed to have been converted into any from (not eligible for registration under section 12 AA ) in a previous year, if-
  • -The registration granted to it under section 12AA has been cancelled ; or
  • -It has modified its objects and not applied for fresh registration (or fresh registration application has been rejected).

Meaning of accreted income – Accreted income shall be amount of aggregate of fair market value of total assets as reduced by the liability as on the specified date (i.e., the date of conversion, merger or dissolution ). Mode of valuation to be notified.

Exclusions from accreted income – So much of the accreted income as is attributable to the following asset and liability, if any, related to such asset shall be ignored for the purpose of computation of accreted income –

1. Any asset which is established to have been directly acquired be the trust or institution out of agricultural income as is referred to in section 10 (1).

2. Any asset acquired by the trust/institution during the period beginning from the date of its creation and ending on the date from which the registration under section 12 AA became effective or deemed effective (however , this rule is valid only if the trust/ institution has not been allowed any benefit of sections 11 and 12 during the said period). “Deemed “ effective covers a case where due to first proviso to section 12 A (2) the benefit of section 11 and 12 have been allowed to the trust/ institution in respect of any previous year prior to the year of registration.

• Further, the asset and the liability of the charitable organisation, which have been transferred to another charitable organisation within specified time, will be excluded while calculation accreted income.

Tax liability – The taxation of accreted income shall be at the maximum marginal rate (i.e.35.535 per cent for the assessment year 2017-18).

This levy shall be in addition to any income chargeable to tax in the hands of the entity and this tax shall be final tax for which no credit can be taken by the trust or institution or any other person, and like any other additional tax, it shall be leviable even if the trust or institution does not have any other income chargeable to tax in the relevant previous year.

2) Mandatory Requirement of obtaining PAN for the Trustees:

Section 139A is amended to the effect that every person, not being an individual, which enters into a financial transaction of an amount aggregating to two lakh and fifty thousand rupees or more in a financial year shall be required to apply to the Assessing Officer for allotment of PAN. This is done in order to use PAN as Unique Entity Number (UEN) for non-individual entities.

It is also provided that the trustee, author, founder, chief executive officer, principal officer or office-bearer or any person competent to act on behalf of such entities shall also apply to the Assessing Officer for allotment of PAN.

This is done in order to link the financial transactions with the natural persons.

 3) Mandatory Requirement of TDS Deduction:

 At present:

• There are no checks on whether such trusts or institutions follow the provisions of deduction of tax at source under Chapter XVII-B of the Act.
• This has led to lack of an audit trail for verification of application of income.

Section 11 provides for exemption in respect of income derived from property held under trust for charitable or religious purposes to the extent to which such income is applied or accumulated during the previous year for certain purposes in accordance with the relevant provisions.

A new Explanation to the said section has been inserted so as to provide that for the purposes of determining the amount of application under clause (a) or clause (b) of sub-section (1) thereof, the provisions of sub-clause (ia) of clause (a) of section 40 and sub-sections (3) and (3A) of section 40A, shall, mutatis mutandis, apply as they apply in computing the income chargeable under the head “Profits and gains of business or profession”.

Non-deduction of tax at source would now attract disallowance in the hands of the charitable trust also. Thus, now trusts will be mandatorily required to deduct TDS as per provisions of Chapter XVII-B of the Act to claim expense as the application of Income. Else the same will be taxable in the hands of Trusts.

4) Disallowance of Expenditure Exceeding Rs. 10,000/- in Cash:

The provisions of section 40(3) and 40(3A) will be mutatis mutandis apply to the Trusts. Earlier, charitable trusts were availing benefits even in respect of the application of income by way of cash payments. This amendment is again in line with the dream of digital India and cashless economy.

Thus, payment exceeding Rs. 10,000 in cash will not be considered as the application of income and the same will be taxable in the hands of trusts.

5) Maximum Limit of Cash Donations reduced from Rs. 10,000/- to Rs. 2,000/-

Restrictions have been imposed on cash donations of the charitable trusts under section 80G by reducing the capping from Rs. 10,000 to Rs. 2,000. This is to ensure that unaccounted money does not flow into the charitable institutions in the form of anonymous donations.

6). Power of Survey u/s 133A:

Giving more powers to the tax authorities, it has been provided that now the income tax officers can conduct surveys under section 133A on trustees and places of activity for charitable purpose.

7) Section 35AC which allowed 100% tax deduction to individuals and companies making contributions to specific charitable organizations for specific schemes, shall no longer be available to donors starting April 1, 2017.

Conclusion: The very rationale of providing tax incentives and exemptions to charitable trusts is to encourage them to render public service and not to accumulate tax-free wealth in the disguise of social service. The Taxation Laws concerning charitable trusts have evolved over a period of time. The recent amendments as incorporated by the Legislature will definitely prevent abuse of tax exemptions and improve tax administration in relation to the charitable trusts.

“There is precious little that’s charitable about the world of charity.”- Richard Cohen

 SO………..

“Do your little bit of good where you are; it’s those little bits of good put together that overwhelm the world.” –Desmond Tutu